Various agents including authors of financial newsletters, financial planners, mutual fund managers and automated systems can produce financial investment advice. Financial investment advice can be distributed via newsletters, mutual funds, automated investment advice tools on a network or through personal interaction. All serve the purpose of assisting investors in achieving personal investment objectives.
Financial investment advice can be categorized as either direct or indirect. Direct investment advice is commonly purchased (through fees or sales commissions) from financial planners and stockbrokers and is used by the investor to make purchase and sale decisions. More recently, direct advice is being offered through the Internet by automated services such as FinancialEngines.com or DirectAdvice.com. Indirect investment advice comes packaged with an investment vehicle. Mutual funds and insurance annuity products are good examples of instances where the advisor is also responsible for conducting transactions for investors.
One problem with direct advice is the lack of a transparent marketplace for individual investors. Most advisors self-report their performance and often do not have a clear methodology for accommodating diverse styles and risk characteristics. Publications, such as the Hulbert Financial Digest, provide analysis of newsletter advice but they cover a limited portion of the direct advice market. Others, such as the Association of Investment Management and Research's (AIMR) Performance Presentation Standards, also attempt to improve performance reporting but adherence is voluntary and still not widespread.
The mutual fund marketplace does have well-developed methodologies for comparing funds. Such methodologies are employed by services like Morningstar and Lipper. This is one of the reasons there are currently 77 million individual mutual fund investors in the U.S. with $2.7 trillion in equity funds and $900 billion in fixed income funds. Other reasons for the popularity of mutual funds include diversification, ease of use, and wide availability in retirement plans. However, investors incur a significant cost for these advantages. The annual cost of maintaining the necessary legal structure, administering the fund, paying the investment managers, and marketing an actively managed fund typically totals from 1.0% to 2.7% of net asset value (NAV). Moreover, the quantifiable costs do not include additional invisible costs that the fund incurs due to the large size of trades. Studies suggest that these costs can add 80 cents per share to the average commission of 5 cents per share. In fact, they are important enough that BARRA has created a product called the Market Impact Model, which predicts the magnitude of this effect for all stocks in the marketplace. In addition, capital gains distributions that are out of the investor's control can have significant negative impacts on after-tax returns.